Norwegian petroleum taxation : estimating the value of allowing companies to pledge tax allowances from investments on the Norwegian continental shelf

Abstract

As the Norwegian continental shelf is maturing, the interest from major international companies is falling. New and smaller players that will have to take over do not have the same credit ratings as the majors, and will thus have to finance their investment activities at a higher interest rate. Additionally, the petroleum industry is characterized by large up-front investments, which forces new players to carry losses forward until they have production on stream. This reduces the value of a project, as the interest rate charged by creditors is much higher than the loss carry forward rate given by the state. Allowing companies to pledge their tax balance will reduce the interest cost, and lower the barriers of entry. Based on the regulations in the Petroleum Tax Act, the cash flow of investments was modeled. Historic numbers and projections of future investments were used to find an applicable investment level. It was assumed that companies could finance the majority of the tax value of investments with debt. Applying an estimate for the industry’s weighted average interest rate provided the interest cost per annum. The value of allowing companies to pledge tax allowances was estimated by adjusting the interest rate to a level representative for secured debt. The model gave an annual interest cost of NOK 7.30 bn. before tax. Tax deductions of interest costs were calculated to be approximately 60 percent, giving an after tax cost of NOK 2.82 bn. After adjusting the interest rate, the interest cost was reduced by NOK 860 mm. This is a reduction of 11.77 percent, with the state receiving NOK 528 mm. and the industry NOK 332 mm. after tax. The Norwegian state is already by law obliged to pay out the remaining depreciation of investments, even if extractive business is ceased. The state would receive the majority of the reduced interest costs through increased tax revenue. More important, cheaper funding costs can help ensure that petroleum activity in Norway is continued in the years to come. Reducing the barriers of entry to the continental shelf could lead to less reliable developments and impose a greater risk for the state, which has to be weighed against the lower interest costs.